Earlier this week the Tenth Circuit Court of Appeals issued an opinion in Mallo v. IRS, holding that certain income tax liabilities were not discharged in bankruptcy because the taxpayers filed late returns after the IRS had already assessed the taxes. Mallo v. IRS, No. 13-1464 (10th Cir. 2014). The issue in that case was whether or not those late tax returns should count as “returns” for dischargeability purposes.
In Mallo, the IRS discovered that the taxpayers had not filed their individual income tax returns for tax years 2000 and 2001. As is customary in such situations, the IRS prepared substitutes for returns under the provisions of I.R.C. sec. 6020(b), issued notices of deficiency, and then assessed income tax liabilities, additions to tax, and interest. After the IRS made these assessments, the taxpayers prepared and filed income tax returns for 2000 and 2001, resulting in an increased liability for tax year 2000 and a reduced liability for 2001. The taxpayers never paid these liabilities in full.
The taxpayers filed a Chapter 13 bankruptcy petition in 2010, which was later converted to a Chapter 7. After the bankruptcy court issued a general order discharging the taxpayers’ debts, the taxpayers filed an adversary proceeding against the IRS to seek a determination that the 2000 and 2001 tax liabilities had been discharged. The bankruptcy court found that these tax debts were not dischargeable because the taxpayers had not, for dischargeability purposes, filed tax returns. The district court affirmed the bankruptcy court’s holding, and the taxpayers appealed to the Tenth Circuit, which also affirmed the holdings of the lower courts.
Bankruptcy Code sec. 523(a) provides that certain debts are excepted from general discharges in bankruptcy. Included in those exceptions are debts “for a tax . . . with respect to which a return . . . was not filed.” Bankruptcy Code sec. 523(a)(1)(B)(i). The flush language (or “hanging paragraph”) of Bankruptcy Code sec. 523(a) provides that “the term ‘return’ means a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements).” The flush language also specifically provides that the term “return” does not include a substitute for return prepared under the provisions of I.R.C. sec. 6020(b). Accordingly, the substitutes for returns that the IRS prepared for the taxpayers under I.R.C. sec. 6020(b) did not count as tax returns, and could therefore not be discharged. The courts were therefore faced with the issue of whether the returns that the taxpayers prepared and filed after the substitutes for returns had already been prepared and assessed should count as tax returns in determining whether the underlying tax liabilities should be discharged.
The Tenth Circuit noted that the lower courts had applied the Beard test to assist in determining whether the late-filed returns should constitute returns for purposes of dischargeability: “[f]irst, there must be sufficient data to calculate tax liability; second, the document must purport to be a return; third, there must be an honest and reasonable attempt to satisfy the requirements of the tax law; and fourth, the taxpayer must execute the return under penalties of perjury.” The court discussed the third part of the Beard test, whether the taxpayers made an honest and reasonable attempt to satisfy the requirements of the tax law when they filed the post-assessment returns, and noted that federal courts have disagreed on this question. However, rather than addressing that question, the Tenth Circuit simply found that the late-filed returns did not comply with applicable filing requirements as required by the flush language of Bankruptcy Code sec. 523(a).
This opinion is important because yet another federal circuit has now held that returns filed after I.R.C. sec. 6020(b) assessments are not dischargeable in bankruptcy.